United States

IRS expands enforcement of micro-captive arrangements

Taxpayers urged to have an independent tax advisor review arrangements

TAX ALERT  | 

In a news release (IR-2020-226) issued Oct. 1, 2020, the IRS announced expanded enforcement methods against taxpayers engaged in abusive micro-captive insurance arrangements and warned that settlement offers in the future would be less favorable than those previously offered. Earlier this year, the IRS sent out letters requesting that taxpayers certify whether they ceased participation in previously reported micro-captive transactions and to disclose the last tax year they claimed a tax benefit from the arrangement. (See our prior alert.) Now, with the October 15th tax deadline approaching, the IRS is encouraging taxpayers to consult an independent tax advisor if they participated in a micro-captive insurance transaction. The IRS also notes that any future settlement offers will not be as favorable as the ones announced in 2019 and will require additional concessions by the taxpayer.

In Notice 2016-66, the IRS designated certain micro-captive insurance arrangements as “transactions of interest.”  Although many taxpayers engage in captive insurance arrangements to legitimately self-insure against business risk, the IRS expressed concern that some arrangements may result in tax abuse. The notice requires taxpayers participating in such arrangements to disclose the transaction on Form 8886, Reportable Transaction Disclosure Statement, and file the form with their current tax return and with the Office of Tax Shelter Analysis. The IRS has successfully litigated several cases regarding abusive micro-captive insurance arrangement in the last few years. 

The October 1 news release warns taxpayers of possible consequences of engaging in abusive micro-captive transactions, such as, disallowing tax benefits from the transactions, requiring domestic captives to include premium payments in income, asserting a withholding liability for foreign captives and asserting penalties, as appropriate, including the strict liability penalty that applies to transactions that lack economic substance. As part of its enhanced scrutiny of the transactions, the IRS has expanded its enforcement efforts with a dedicated promoter office, a new Fraud Enforcement Office, enhanced service-wide coordination with Criminal Investigation and the Office of Professional Responsibility and advanced data analytics and mining capabilities.

The news release also warns that it is aware of new variations to micro-captive transactions that are designed to skirt the reporting requirements of Notice 2016-66. One such potentially abusive captive insurance arrangement uses offshore captive insurance companies domiciled in Puerto Rico, and elsewhere, as opposed to section 831(b) captives. This and other variations avoid the reporting requirements of Notice 2016-66 but may have the same or similar abusive elements as abusive micro-captive insurance transactions. The IRS has said it is aware of these abusive transactions and is actively working to counter their spread.

Over the summer, the IRS sent information requests under section 6112 to material advisors regarding micro captive insurance. Section 6112 requires that material advisers maintain client lists for those clients that they act as material advisors for a reportable transaction. In addition, the IRS has formed 12 additional micro-captive examination teams to increase the examinations of potentially abusive micro-captive insurance transactions.

WNT takeaways

Taxpayers who participate in a micro-captive insurance arrangement should consult with their tax advisors to make sure they are not engaging in abusive transactions. Further, taxpayers need to be sure they are filing the appropriate disclosures forms for any micro-captive insurance arrangements they are engaging in. Taxpayers should be aware of the IRS’s heightened scrutiny and ensure they have the proper documentation in place to withstand an investigation into their micro-captive insurance arrangements. 

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